OPEC: Some Kind of a Deal from Vienna

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December 5, 2016

The agreement reached by OPEC in Vienna on Wednesday to cut oil production by 1.2 million barrels had an immediate impact on oil markets—causing WTI and Brent crude to surge over 10% from Tuesday’s close. Although the markets are celebrating the first OPEC production agreement since 2008, we assess the true impact of the deal to be far more obscure.

With the exception of Iran, Libya, Nigeria and Indonesia (which was suspended from OPEC on Wednesday), OPEC members agreed to cut between 4.6% and 5% of their production from an agreed reference level. Iran was allowed to continue to increase production up to 3,797 thousand barrels per day and Libya and Nigeria were not subjected to any limits on their production. The deal also includes a cut of 600 thousand barrels a day from non-OPEC members, with 300 barrels per day coming from Russia. The non-OPEC cuts will be negotiated with those parties on December 9 in Vienna.

Before the OPEC meeting in late November we assessed a deal was likely, in part because of the intense pressure to demonstrate that OPEC is still functional and relevant, despite serious internal political disagreement among members. Furthermore, the largest producer, Saudi Arabia has a heightened interest in seeing oil prices rise in 2017 and 2018 as they look to make an initial public offering of Aramco to diversify their economy and address serious budget problems.

It is too early to say whether Wednesday’s deal will amount to a long-term increase in oil prices. There are several good reasons to be skeptical:

The cuts take advantage of record and near-record production levels that are quite possibly inflated;

The largest cut by volume comes from Saudi Arabia and will likely be at least partially absorbed in decreased seasonal domestic consumption there, meaning Saudi exports may not change significantly;

The monitoring team of Kuwait, Algeria and Venezuela will face serious challenges detecting whether cuts of this size are actually being implemented;

Producers not party to the agreement, especially Canadian, American, Libyan and Nigerian producers have the potential to replace lost production in the near future, especially if prices rise in the short-term.

Determining the actual impact on oil production and global supply will require careful analysis of good data. Furthermore, close on the horizon, the incoming Trump administration’s policies are likely to increase American demand for fossil fuels by easing regulations, lowering taxes and otherwise encouraging consumption. Chinese growth remains a serious question mark and could impact demand levels significantly. Ankura’s team of oil and gas experts, economists and geopolitical analysts has the experience and expertise to provide timely insights and accurate forecasts on these developments.